EUR Traders Beware – ECB Rate Cut Talk Could Gain Momentum

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The sharp sell-off in the EUR/USD at 10am NY Time took the focus completely off the Bank of Canada’s monetary policy announcement. The euro was hit hard by the decline in U.S. stocks and comments from ECB policymaker and Bundesbank President Jens Weidmann who said the central bank could cut interest rates if new information warrants it. If the ECB is serious about cutting rates, it would be a significant enough catalyst for this sell-off in euro last. We know that economic data out of the Eurozone has taken a turn for the worse and the simultaneous slowdown in the U.S. and China could hurt the region more by negatively affecting export demand. German stocks haven’t been holding up nearly as well as U.S. equities and this only adds to the ongoing pressure of austerity on the region’s economy.

The ECB is a central bank that likes to prepare the market for any potential changes in monetary policy and that is why Weidmann’s comments are so important because it could be the first of many to follow. A rate cut is clearly on the table and if data confirms the need for additional easing, the ECB may not hesitate to cut rates especially with the recent decline in commodity prices, which reduces inflationary pressures.

As for Canada, the central bank left interest rates unchanged at 1%, downgraded their 2013 GDP forecast and upgraded their 2014 forecast. Unfortunately their downward revision for 2013 from 2% to 1.5% far exceeded their 0.1% upward revision for 2014. As a result, the Canadian dollar sold off even as the Bank of Canada repeated that a modest withdrawal of stimulus would likely be required in the future. For the time being however, there is “material slack” in the economy and for this reason, interest rates remain appropriate. Overall, the BoC has moved further away from a rate hike with their revisions to GDP and comment on material slack reemergence.

Meanwhile in the U.S., the Federal Reserve’s Beige Book report will be the central focus during the North American session. The main question that investors will be looking for an answer on is whether the weakness in March extended into April. The Beige Book provides the Fed with an up to date assessment of how the economy is doing through a district by district summary of conditions. If the Fed districts say that the weakness in the labor market and consumer spending persisted, USD/JPY along with other high beta currencies could extend their slide as a wave of risk aversion hits the market. However if they say there have been signs of improvement, the optimism could revive the rally in the EUR/USD and USD/JPY as investors interpreted the deterioration last month as a temporary one month phenomenon.

Kathy Lien
Managing Director

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